PDF GAO-18-421, SMALL BUSINESS LOANS: Additional Actions Needed ...

June 2018

United States Government Accountability Office

Report to Congressional Committees

SMALL BUSINESS LOANS

Additional Actions Needed to Improve Compliance with the Credit Elsewhere Requirement

GAO-18-421

Highlights of GAO-18-421, a report to congressional committees

June 2018

SMALL BUSINESS LOANS

Additional Actions Needed to Improve Compliance with the Credit Elsewhere Requirement

Why GAO Did This Study

SBA's 7(a) program is required to serve creditworthy small business borrowers who cannot obtain credit through a conventional lender at reasonable terms. The Joint Explanatory Statement of the Consolidated Appropriations Act, 2017 includes a provision for GAO to review the 7(a) program.

This report discusses, among other things, (1) how SBA monitors lenders' compliance with the credit elsewhere requirement, (2) the extent to which SBA evaluates trends in lender credit elsewhere practices, and (3) lenders' views on the credit elsewhere criteria for 7(a) loans.

GAO analyzed SBA data on 7(a) loans approved for fiscal years 2007?2016, the latest available, and reviewed literature on small business lending; reviewed standard operating procedures, other guidance, and findings from SBA reviews performed in fiscal year 2016; and interviewed lender associations and a nonrepresentative sample of 7(a) lenders selected that concentrated on larger lenders.

What GAO Recommends

GAO recommends that SBA (1) require its on-site reviewers to document their assessment of lenders' policies and procedures related to the credit elsewhere documentation requirement, (2) collect information on lenders' use of credit elsewhere criteria, and (3) analyze that information to identify trends. SBA generally agreed with the recommendations.

View GAO-18-421. For more information, contact William B. Shear at (202) 512-8678 or shearw@.

What GAO Found

For its 7(a) loan program, the Small Business Administration (SBA) has largely delegated authority to lenders to make 7(a) loan determinations for those borrowers who cannot obtain conventional credit at reasonable terms elsewhere. To monitor lender compliance with the "credit elsewhere" requirement SBA primarily uses on-site reviews conducted by third-party contractors with SBA participation and oversight, and other reviews. According to SBA guidance, lenders making 7(a) loans must take steps to ensure and document that borrowers meet the program's credit elsewhere requirement. However, GAO noted a number of concerns with SBA's monitoring efforts. Specifically, GAO found the following:

? Over 40 percent (17 of 40) of the on-site lender reviews performed in fiscal year 2016 identified lender noncompliance with the requirement.

? On-site reviewers identified several factors, such as weakness in lenders' internal control processes that were the cause for lender noncompliance.

? Most on-site reviewers did not document their assessment of lenders' policies or procedures, because SBA does not require them to do so. As a result SBA does not have information that could help explain the high noncompliance rate.

Federal internal control standards state that management should design control activities, including appropriate documentation, and use quality information to achieve the entity's objectives. Without better information on lenders' procedures for complying with the documentation requirement, SBA may be limited in its ability to promote compliance with requirements designed to help ensure that the 7(a) program reaches its target population.

SBA does not routinely collect or analyze information on the criteria used by lenders for credit elsewhere justifications. SBA recently began collecting some information on lenders' use of the criteria, but this information is limited, and SBA does not analyze the information that it does collect to better understand lenders' practices. Federal internal control standards state that management should use quality information to achieve the entity's objectives. Without more robust information and analysis, SBA may be limited in its ability to understand how lenders are using the credit elsewhere criteria and identify patterns of use by certain lenders that place them at a higher risk of not reaching borrowers who cannot obtain credit from other sources at reasonable terms.

In general, representatives from 8 of 11 lenders that GAO interviewed stated that SBA's credit elsewhere criteria are adequate for determining small business eligibility for the 7(a) program. These criteria help them target their lending to small businesses that would otherwise have difficulty obtaining conventional credit because they are often new businesses or have a shortage of collateral. However, they also said that other factors--such as lender policies and economic conditions--can affect their decisions to offer 7(a) loans. In January 2018, SBA issued revised guidance for the 7(a) program and has provided training on this new guidance to lenders and trade associations. Lenders told GAO they are still in the process of understanding the new requirements.

United States Government Accountability Office

Contents

Letter

Appendix I Appendix II Appendix III Appendix IV Appendix V Table

1

Background

3

Businesses That Were New, Women-Owned, or Located in

Distressed Areas Received a Majority of 7(a) Loan Dollars over

the Past 10 Years

8

SBA Has Processes in Place to Evaluate Lender Compliance, but

Its Lender Reviews Do Not Document Reasons for

Noncompliance

15

SBA Collects Limited Data on Criteria Used for Credit Elsewhere

Justifications and Does Not Analyze Patterns in Lender

Practices

22

Lenders Generally View Credit Elsewhere Criteria as Adequate,

and SBA Has Implemented New Procedures for Reviewing

Eligibility

25

Conclusions

28

Recommendations for Executive Action

29

Agency Comments and Our Evaluation

29

Objectives, Scope, and Methodology

32

Selected Characteristics of 7(a) Lending, Fiscal Years 2007?2016 36

Information on Borrower Characteristics Based on SBA's Predictive

Scores

39

Comments from the Small Business Administration

41

GAO Contact and Acknowledgments

44

Table 1: Share of the Total 7(a) Loans for the Top Eight Industrial

Sectors by NAICS Code, Fiscal Years 2007?2016

37

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GAO-18-421 Small Business Loans

Figures

Figure 1: Percentage of 7(a) Loan Dollars That Went to

Businesses That Were New, Women-Owned, or Located

in Distressed Areas, Fiscal Years 2007?2016

9

Figure 2: Percentage of 7(a) Loans by Status as a New Business,

Fiscal Years 2007-2016

10

Figure 3: Percentage of 7(a) Loans by Gender of Ownership,

Fiscal Years 2007-2016

11

Figure 4: Percentage of 7(a) Loans to Borrowers in Economically

Distressed Areas and Noneconomically Distressed

Areas, Fiscal Years 2007?2016

12

Figure 5: Percentage of 7(a) Loans to Minority and Nonminority

Borrowers, Fiscal Years 2007?2016

14

Figure 6: Number, Average Amount, and Total Amount of 7(a)

Loans Approved, Fiscal Years 2007?2016

36

Figure 7: Fiscal Year 2016 Total Approved 7(a) Loan Dollars and

Per Capita Approved Loan Dollars by State

38

Abbreviations

NAICS SBA

North American Industry Classification System Small Business Administration

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GAO-18-421 Small Business Loans

441 G St. N.W. Washington, DC 20548

Letter

June 5, 2018

Congressional Committees

In recent years, the Small Business Administration's (SBA) 7(a) program--SBA's largest loan guarantee program for small businesses-- has grown considerably.1 The program is required to serve creditworthy small business borrowers who cannot obtain credit through a conventional lender at reasonable terms--commonly referred to as the "credit elsewhere" requirement.2 In July 2015, SBA was forced to suspend 7(a) lending after the program hit its $18.75 billion annual loan ceiling with more than 2 months left in the fiscal year. Congress subsequently raised the loan ceiling to $23.5 billion and further to $27.5 billion in fiscal year 2017. In response to this growth, members of Congress have raised concerns about guaranteed loans going to borrowers that are able to obtain conventional credit at reasonable terms and whether the criteria currently used to satisfy the credit elsewhere requirement provide reasonable assurance that guaranteed loans are approved for only qualified borrowers.

The Joint Explanatory Statement of the Consolidated Appropriations Act, 2017, includes a provision for us to conduct a study of the credit elsewhere requirement, including the sufficiency of the credit elsewhere criteria. This report discusses (1) 7(a) lending to selected categories of small business borrowers from fiscal years 2007 through 2016; (2) how SBA monitors lenders' compliance with the credit elsewhere requirement; (3) the extent to which SBA evaluates trends in lender practices related to the credit elsewhere requirement; and (4) lenders' views on the criteria used to determine eligibility for 7(a) loans and other issues related to the 7(a) program.

1The loan guarantee covers part of a lender's losses in the event of a borrower default, reducing the risk of lending to small businesses that would otherwise not qualify for loans at reasonable terms from commercial lenders. Section 7(a) of the Small Business Act, now codified at 15 U.S.C. ? 636(a), provides the authority for the 7(a) program.

2Reasonable terms and conditions take into consideration "the prevailing rates and terms in the community in or near which the concern transacts business, or the homeowner resides, for similar purposes and periods of time." 15 U.S.C. ? 632(h). SBA also requires lenders certify that 7(a) borrowers cannot obtain financing from personal resources or the resources of the business or its owners of 10 percent or more.

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